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Designing Financial FreedomSun, 17 Feb 2019 12:30:04 +0000en-UShourly1https://wordpress.org/?v=5.0.3Roth IRA vs. Traditional IRA – Which One Is Better for You?http://feedproxy.google.com/~r/MyMoneyDesign/~3/xNRZ33vecdw/
http://www.mymoneydesign.com/personal-finance-2/retirement/roth-ira-vs-traditional-ira/#commentsSun, 17 Feb 2019 06:00:18 +0000http://www.mymoneydesign.com/?p=9744When it comes to retirement accounts, there’s one debate that almost everyone must consider: A Roth IRA vs. Traditional IRA – Which one is better? What are the differences, and how do I know which one is the right one for me? As someone who has both a Roth and a Traditional account, let me […]

When it comes to retirement accounts, there’s one debate that almost everyone must consider: A Roth IRA vs. Traditional IRA – Which one is better? What are the differences, and how do I know which one is the right one for me?

As someone who has both a Roth and a Traditional account, let me tell you: Each one has traits that can be very valuable to you in their own way!

In general, no matter which one you choose, you’re doing a great thing by taking advantage of a unique opportunity from the IRS to save and grow your money without having to pay taxes right away (or in some cases, never).

Over time, when compared to a “regular” savings or investment account, these tax-advantages will add up in an incredible way. For some people, this might mean an additional five, six, or seven figures of wealth in their nest eggs over time!

But just like many decisions in personal finance, the devil is always in the details. Choosing either a Roth or Traditional account will determine exactly how your savings gets taxed, how it grows, when you can withdraw it, and even what happens to it after you pass away.

With so many variables to consider, how will you know which one is really the better choice for your money?

Fortunately, our comprehensive guide below will tackle each one of the theses questions and break down everything important that you need to consider. More importantly, after understanding a few key concepts, you’ll gain confidence in your decision about going with one type of account over another.

So with that said, let’s start by learning about the differences between a Traditional IRA vs Roth IRA.

What is the Difference Between a Roth vs. Traditional IRA?

The decision as to which type of IRA to go with really boils down to one very important question:

Would you like to pay your taxes now or later?

How a Traditional IRA Works:

With a traditional IRA, the process works as follows:

You earn an income and decide that you’d like to save a portion of it into the traditional IRA.

Whatever you save gets subtracted from your gross annual income at the end of the year when you file your tax return. In other words, you pay no taxes on this saved income for the year.

Your contributions grow throughout the years as the investments you’ve selected fluctuate in value. During these years, you still do not pay any taxes on your contributions or the earnings they generate.

Finally one day, you retire. When this happens, you dip into your traditional IRA and make a withdrawal. Now that the money (contributions and earnings) has finally been withdrawn, you will pay taxes on it.

This is why traditional IRA distributions are often referred to as “tax-deferred”. In exchange for saving for retirement, the IRS has allowed you to delay paying tax on this income and its earnings until you retire and finally use the money.

If you already have a traditional 401(k) plan through your employer, than you will notice that this process of deferring taxes on your savings is very similar.

How a Roth IRA Works:

By contrast to a traditional IRA, with a Roth IRA, the rules for paying taxes are the reverse.

You earn an income and decide that you’d like to save a portion of it into the Roth IRA.

Whatever you save gets does not get subtracted from your gross annual income at the end of the year when you file your tax return. In other words, you still pay taxes on this income for the year just like all the other income you’ve earned.

Your contributions grow throughout the years as the investments you’ve selected fluctuate throughout in value. During this time, you do not pay any taxes on your gains; nor will you ever.

Finally one day, you retire. When this happens, you dip into your Roth IRA and make a withdrawal. Any money you withdraw from it, contributions or earnings, will be tax-free (since you’ve paid taxes on it once before).

This is why Roth IRA distributions are often referred to as “tax-free” income. In exchange for paying your taxes up-front and saving towards retirement, the IRS will allow you to make withdrawals tax-free when you are retired.

If you work somewhere that offers a Roth-style 401(k) plan, than you will again notice that this process of paying taxes up-front in exchange for tax-free distributions later is very similar.

Which One is Better? – The Tax Implications

Are there times when a Roth IRA will be better than a traditional IRA, or vice versa?

Absolutely! However, to truly answer that question, you have to look at your personal financial situation and determine two very important things:

Your tax rate now

Your tax rate when you retire

Example Where a Traditional IRA is Better:

Let’s say that during your working years, your household income is $100,000 per year. You and your spouse decide to make a plan for retirement where you will only need $60,000 per year to cover your living expenses.

Let’s assume you file your taxes as “married filing jointly”. If you paid taxes now on your retirement savings while you’re working, you’d be in a higher tax bracket than when you retire.

Therefore, using the traditional IRA and waiting to pay your taxes would be the better option.

Example Where a Roth IRA is Better:

Now let’s take the same scenario, but only this time we’ll reverse everything.

This time, you’re earning $60,000 of household income per year. But when you retire, you’re on track to bring in $100,000 per year of retirement income. In this case, you’d be in a lower tax bracket now than when you retire.

Therefore, it would be better to go with the Roth now and pay taxes while your rate is lower.

A BIG “If”

This is all, of course, assuming nothing drastic changes between now and then with the tax code. It also assumes that the government doesn’t make any changes to the rules for Roth IRA’s. For example, what if they suddenly started adding some small, new redemption fee or tax at the time of retirement?

Let’s hope not ….

Is It Possible to Pay No Taxes At All?

Yes!

I want to emphasize that there are lots of ways to lower your tax bill. If you’re clever, you could structure your income so that you owe nothing at the end of the year.

Example: Let’s say you’ve been saving for years using a combination of traditional IRA, Roth IRA, and taxable investments (such as dividend paying stocks).

You plan to get retirement income from the following sources:

$10,000 from your Roth IRA

$20,000 from your traditional IRA

$10,000 from your dividend stocks

Because of the way that taxes work, you would owe nothing on your Roth IRA distributions. You’d also owe nothing on your dividend stocks because you’re under the $75,900 threshold for dividend income (assuming married filing jointly).

So the only income we need to consider is that from the traditional IRA. But remember that you get to subtract your standard deduction and two personal exemptions ($12,700 + (2 x $4,050) = $20,800) . Because these subtractions are greater than the income from your traditional IRA, your taxable income drops to $0.

Yes! You’ve paid NO taxes when you first saved, NO taxes on the earnings, and NO taxes at retirement. Well done!

Which IRA Came First?

Here’s some fun trivia for you to impress your friends at parties …

Traditional IRA’s were established in 1974 after the Employee Retirement Income Security Act (ERISA), a plan that was enacted to protect the interests of employee benefit plan participants.

Roth IRA’s began in 1997 after the Taxpayer Relief Act was established. They are named after Senator William Roth, the chief legislative sponsor of the plan.

What are the IRA Maximum Contribution Limits?

As of 2019, the maximum contribution per year to an IRA is $6,000 per person.

In a house where both the spouses are eligible, both people can contribute separately to their own IRA’s for a total of $6,000 x 2 = $12,000 per household.

For example: Assuming eligibility is met, you could put $4,000 towards your Roth IRA and $2,000 towards your traditional IRA for a total savings of $6,000.

However, you could NOT contribute $6,000 to your traditional IRA and $6,000 to your Roth IRA because your total contribution of $12,000 would exceed the $6,000 limit.

Catch-Up Contributions for Older Contributors:

If you are age 50 and older, you have the option to increase your maximum contribution by $1,000 to $7,000 total. You will often hear this referred to as the “catch-up” contribution. This gives older contributors the ability to save more since they are closer to retirement and may need the extra amount to help achieve their savings goals.

Effectively Saving More with the Roth IRA:

Because of the tax implications of “pay now” or “pay later”, many financial enthusiasts will argue that you effectively get to save MORE of your money with the Roth IRA.

Here’s the argument:

With a traditional IRA, you set aside $6,000 for the year and pay no taxes on this amount. Therefore, you’ve saved a net of $6,000. Of course at some later date when you are ready to retire, the assumption is that you will pay taxes on this amount. For example: If you’re in the 22% tax bracket, then $6,000 x .22 = $1,320 for a net of $4,680 available to spend.

With a Roth, the numbers work out differently. Even though you have the same restrictions to save $6,000 for the year, remember also that you have to pay taxes on this contribution. Putting the two elements together, that’s a net out-of-pocket withdraw of $6,000 into your Roth and $1,320 in taxes for an effective $7,320 applied towards retirement. When you finally get to the point of retirement, you pay no taxes on that $6,000 contribution. Therefore, the entire $6,000 is available for spending.

Contribution Deadlines for IRA’s

Your last opportunity to contribute to your IRA is always the tax-filing deadline of the following year. For 2018 contributions, the last day is 4/15/2019. In other words, as long as you invest before this date, you could put $6,000 in your IRA as your 2018 contribution and then add another $6,000 going forward for 2019.

Who Can Contribute to an IRA?

Generally speaking, any U.S. tax-payer can contribute to an IRA as long as they’ve earned a taxable income this year (i.e. they have a job). Non-working spouses who have a spouse that earns taxable income and files jointly are also allowed to contribute to an IRA.

If your taxable compensation was less than the maximum contribution limit for the year, then your taxable compensation becomes the new limit.

That last point is especially important for children who have a part-time job and their parents encourage them to stash their savings in an IRA. For example, if you earned $3,000 for the year, then the most you can contribute to your IRA is $3,000. However, keep in mind that the contribution doesn’t necessarily have to come from the child. If the parent wanted to reward the child for working the summer job, then they could make the $3,000 contribution on the child’s behalf, and this would be acceptable.

Traditional IRA Deductions:

Traditional IRA’s are an interesting thing. As we said, most anyone with a taxable income can contribute to one. But the question is whether or not you’ll get a tax deduction.

What’s a tax deduction?

Remember in the very beginning of this article how we said that if you save your money in a traditional IRA, you don’t have to pay taxes on it for the year? That’s called a tax deduction. That savings got “deducted” from your taxable income.

Well, as it turns out, the ability to take this deduction and delay paying taxes on your savings is only available to certain people.

How do you qualify?

Your ability to take an IRA deduction will depend on two important factors:

Example: For a married couple filing jointly, your MAGI needs to be $103,000 or less to be able to deduct the full amount. Up to $123,000, you can take a partial deduction. At $123,000 or higher, there is no deduction.

Example: For a married couple filing jointly, your MAGI needs to be $193,000 or less to be able to deduct the full amount. Up to $203,000, you can take a partial deduction. At $203,000 or higher, there is no deduction.

If there’s no deduction, would I still want to contribute?

Yes. Remember that once your money is inside the IRA, it will grow tax-deferred for years. Not having to pay taxes on the capital gains every year can add up significantly over time.

Roth IRA’s:

Roth IRA’s are slightly more straight-forward with their requirements.

With a Roth, you either “can” or “cannot” contribute to them. This will be based on your MAGI. Here are the IRS limits.

Example: For a married couple filing jointly, your MAGI needs to be $193,000 or less to be able to contribute the full amount. Up to $203,000, you can make a partial contribution. At $203,000 or higher, no contribution can be made.

Age 70-1/2:

After age 70-/12, you can no longer contribute to a traditional IRA. You can however keep on contributing to a Roth IRA if you wish.

Where and How Do I Start an IRA?

You can start an IRA with literally an financial institution or bank out there. There are thousands of options.

Personally, I like to use the company Vanguard. They are the largest mutual fund company in the world, and they have the lowest fees of any provider I know of.

Most places will request that you invest some nominal amount of money to start your IRA; usually $2,000 or more. I believe the Vanguard STAR fund has one of the lowest minimum investments at $1,000.

Once you’re invested, you can then make much smaller contributions (again, according to whatever rules the financial institution has in place.) For example, with the Vanguard STAR fund, additional contributions must be $1 or higher.

Generally, most people will invest in mutual funds when they open an IRA. Those mutual funds can then invest in any number of assets: Stocks, bonds, international, real estate, gold, etc.

You can also invest directly in those assets within your IRA. However, this should only be done after you’ve had some experience with investing.

What Are the Withdrawal Rules for Traditional and Roth IRA’s?

Though the intention with any tax-advantaged retirement account is not to touch your money until much later in the future, in short, there are ways to access your money if you truly want to.

Traditional IRA’s:

For traditional IRA’s, the rules are making withdrawals are very similar to a 401(k) plan. Any distributions prior to age 59-1/2 will be subject to a hefty 10% penalty and applicable taxes. There are a few exceptions to this rule such as a first-time home purchase, qualified education expenses, death, etc.

Roth IRA’s:

For Roth IRA’s, the process is not as straight-forward.

You have to think of your Roth IRA in terms of two parts: Your contributions and the gains that they have earned.

Your contributions are always penalty-free and available for withdraw because you’ve already paid taxes on this money. This again can be helpful for early retirement planners who are trying to find strategic ways to bridge the gap between whenever they retire and age 59-1/2.

However, your gains are not available for withdraw until age 59-1/2 unless you want to pay the 10% penalty fee. Afterwards, they are available for withdraw tax-free and penalty-free.

Also keep in mind that there is a little known rule that the first time you start a Roth IRA, you need to keep your contributions inside the Roth for at least 5 years in order for the gains to become tax-free. If you withdraw your contributions before this, then any gains they’ve accrued will not be tax-free, even after you reach age 59-1/2. Once you’ve reached this 5 year threshold, you don’t have to do the same with other contributions or even other Roth IRA’s. It’s just on the first one.

Unlike the traditional IRA, Roth IRA’s do not have required minimum distribution rules since you’ve already paid taxes on the contributions and the earnings are tax-free. Therefore, you could keep as much of your money in the Roth for as long as you wish. If you’ve got secondary motives for building your fortune such as leaving money to an heir, then this might be a useful strategy to explore.

What is a Rollover IRA?

Anytime you have an old 401(k) or other retirement fund that you’d like to move over to your preferred financial institution, you can do so by performing what’s called a “rollover” into a Rollover IRA. For all intents and purposes, think of a Rollover IRA the same as a traditional IRA.

When I left my old job, I simply rolled over my old 401(k) into a Rollover IRA with my other retirement accounts. Not only were the anticipated annual investment fees lower, but it also made life easier to have everything in one spot.

Be careful! You can elect to move a traditional 401(k) to a Roth Rollover IRA. But when you do, you’ll be on the hook for paying all the taxes that are due as part of that conversion! For example, if you have $500,000 that you intend to rollover, this $500,000 would get added on top of your taxable income and leave you on the hook to pay upwards of 40% taxes for the year!

The same would be true of you moved a Roth 401(k) into a regular traditional Rollover IRA.

To keep things safe, be sure to only do “traditional to traditional” and “Roth to Roth” rollovers.

Conversions

Traditional to Roth:

It is possible to convert portions of your traditional IRA to a Roth. When this happens, you owe taxes on whatever amount you wish to convert.

As simple as that may sound, this process is actually a very popular loop-hole known as the backdoor Roth conversion.

For people who earn too much to contribute to a Roth IRA, they can still do so by first making a non-deductible contribution to a traditional IRA. They can then convert any amount of this savings over to a Roth. By doing so, the potential earnings they will make move from being tax-deferred to tax-free.

This is also a useful technique for early retirement planners. Any money that gets converted becomes penalty-free after a five-year waiting period. Therefore, you could effectively create a “ladder” of penalty-free distributions year after year.

Roth to Traditional:

If for some reason you need to convert your Roth savings over to a traditional account, you can perform what’s called a “recharacterization”. This can be done simply by contacting your financial institution and filling out the appropriate paperwork.

IRA Beneficiaries

Traditional IRA’s:

If you leave your traditional IRA to your spouse, then they can treat it as if it was their own. However, if you leave it to someone other than your spouse (such as child or grandchild), then they will be required to pay taxes on it as well as take required minimum distributions.

Roth IRA’s:

Conclusions: Which IRA Really Is Better?

Okay! So now we know everything there is to know about IRA’s. After all that, which one is really the best?

As you might guess, there’s just no simple answer. There are several factors that will play into your decision. And the amount of weight you decide to give to each of those priorities will ultimately determine how much better one type of IRA is over the other.

In closing, if we consider all things to be equal, then I would lead with the following decisions:

See if you qualify for a deductible or non-deductible traditional IRA.

If you qualify for a deductible traditional IRA and you believe your tax rate will be lower during retirement, then go for the traditional IRA.

If you don’t qualify for a deductible traditional IRA but you believe your tax rate will be lower during retirement, then still go for the Roth IRA.

If you believe your tax rate will be higher during retirement, then go for the Roth IRA.

Want to know more about IRA’s, 401(k)’s, and other interesting ways to save more for retirement? Please check my ebook “Save BETTER!” to learn about some strategies you can use to maximize your wealth building efforts.

Readers – What factors do you consider when choosing between a Roth IRA vs traditional IRA?

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/roth-ira-vs-traditional-ira/feed/10http://www.mymoneydesign.com/personal-finance-2/retirement/roth-ira-vs-traditional-ira/How Do You Know When to Drop Collision and Comprehensive Coverage?http://feedproxy.google.com/~r/MyMoneyDesign/~3/SX-WQjm_-Rw/
http://www.mymoneydesign.com/personal-finance-2/insurance-planning/how-do-you-know-when-to-drop-collision-and-comprehensive-coverage/#respondSun, 10 Feb 2019 18:00:19 +0000http://www.mymoneydesign.com/?p=11101Have you ever wondered when to drop collision and comprehensive coverage from your auto insurance policy? Without a doubt, auto insurance is a must-have when your vehicle is relatively new, higher in value, and you need the financial protection. But what happens as time goes on and our vehicles begin to decrease in value? What […]

Have you ever wondered when to drop collision and comprehensive coverage from your auto insurance policy?

Without a doubt, auto insurance is a must-have when your vehicle is relatively new, higher in value, and you need the financial protection.

But what happens as time goes on and our vehicles begin to decrease in value? What about when you’ve racked up hundreds of thousands of miles, and you know the trade-in value of your car will be next to nothing? Is there a point where full coverage simply doesn’t make good financial sense any longer?

This is a question I struggle with every time I have to renew my auto insurance policy. I commute every day over 60 miles each way to and from work. Traditionally, to get the most bang for my buck, I purchase relatively inexpensive used cars and drive them until my millage is well into six digits.

Conventional wisdom says to drop full coverage if it exceeds 10% of the replacement value of your car. For example, if you stand to receive $5,000 if you’re in an accident, then your insurance shouldn’t cost more than $500 per year.

But does this 10% rule of thumb really always hold true? What if you drop your coverage and get in an accident right away? Honestly, how much savings are you really going to get and how long would you have to go without an accident for it to be financially better?

More so, is there a break-even point where paying for comprehensive and collision coverage would barely cover your car if you were in an accident (if at all)? Or could I be passing up better financial opportunities such as paying off some debt, adding it to my retirement savings, or simply building up my rainy day fund?

In this post, I’d like to explore my options and crunch the numbers. Most importantly, I’d like to see if the benefits really do out-weigh the risks, or if it simply makes more sense to keep comprehensive and collision and simply adjust the deducible (more on that below). But first: What is comprehensive and collision coverage?

What is Comprehensive and Collision Coverage?

What does it mean to have comprehensive and collision? Why is it important to even have this type of coverage on your auto insurance in the first place?

Collision insurance covers the damage to your vehicle in the event that you are in an accident with another vehicle. An example of this would be a typical car-crash scenario where one car hits another.

Comprehensive insurance pays for non-collision related damage. An example of this would be a broken windshield due to a flying rock or hail.

Are comprehensive and collision insurance required by law?

Generally, no. State laws don’t require you to have coverage that protects the physical appearance of your car. However, keep in mind that if you have an auto loan, they might require you to keep full coverage (to protect their asset, of course).

What does the law require? That you are financially responsible for any injuries or damage you cause as a result of your driving. Hence, why you have Bodily Injury Liability and Property Damage Liability. The minimum amounts will vary from state to state.

Then why even buy comprehensive and collision ?

Like all insurance policies, your goal is to minimize your financial risk and protect your asset from unfortunate events.

Imagine you just bought a brand-new $40,000 SUV and get into an accident one mile from the dealership. Even though no one is hurt, without insurance, you would be on the hook for tens of thousands of dollars associated with repairing your vehicle. So by having insurance, you mitigate that risk by paying a relatively small sum of money for the insurance provider to pay those expenses should anything accidental occur.

Deductibles

Keep in mind that collision and comprehensive coverage costs will vary depending on your deductible. Your deductible is the amount of money you must pay first when a claim is made before the insurance company will pay any benefits.

Example: You are in an accident and have $5,000 of damages. Your deductible is $500. Therefore, you pay the first $500 while the insurance company covers the remaining $4,500 for the repair.

Typically most people select deductibles between $500 and $1,000 depending on a great deal of factors like price, comfort level, accident history, etc.

Depending on your type of policy, you might not have to pay the deductible yourself. If you have what’s called “broad from” insurance and you are determined to be less than 50 percent at fault for the accident, then the other party (or rather their insurance company) will pay for your deductible.

My 3 Possible Auto Insurance Options to Consider

To really determine if keeping collision and comprehensive coverage makes sense, I decided to call my insurance provider to get figures on a few different options. (Yes, these are REAL numbers!)

Basically I see three main options we could choose from:

Keep the coverage with a $1,000 Deductible. Right now my auto insurance policy carries a $1,000 deductible for collision and comprehensive. If I stay this route, I can change nothing and continue to pay the same rate I’ve always paid.

Keep the coverage with a lower $500 Deductible. I could reduce my deductible to $500 and pay a higher price of $41.05 more every 6 months ($82.10 per year). If I get into an accident, then we can assume I’d have less to pay out of my own pocket (assuming I have to pay the deductible at all).

No Coverage. I could drop collision and comprehensive from my policy altogether and save $131.46 every 6 months ($262.92 per year). However, if I get into an accident, then it’s game over! I would have to pay for all the damages myself (or more than likely start looking for another used car).

Worst-Case Scenario: I Pay the Deductible After the Accident

To really appreciate a good analysis, I find its best to start extreme and compare all three options assuming the worst-case scenario.

In this model, what circumstances would make it worst-case?

First of all, let’s perform the calculation assuming I was in a car accident and my vehicle was completely totaled at the end of each 6 month period (starting from 0 to 30 months). As time builds on, we’ll see the cumulative effect of the savings versus the depreciating effect of the vehicle (resulting in the net amount of money I will be entitled to receive).

Let’s also assume that I have to pay the deductible, not the other party. How likely is that? Unfortunately, more than you think. The last accident I was in included someone who claimed to have insurance but turned out to have none. My insurance company sent her legal notices, but there was never any response. So I was on the hook for paying for the entire deducible. Again, we want to assume worst-case.

Finally, we’ll need to estimate the depreciation of my vehicle. For your information, I drive a 2011 Chrysler 200 (that I picked up for a steal!). It currently has over 150,000 miles (I told you I commute a lot!) and has an estimated value of roughly $2,000. Since my car is at the tail end of its life-cycle value, I think we could reasonably assume a decrease of $200 of Blue-Book value with every 6-month insurance period.

Results

Observations

1. If
I totaled my car tomorrow, clearly switching to the $500 would yield the
greatest value whereas
dropping collision and comprehensive would result in the least value.

2. If I can manage to stay accident free for at least 16 months, then dropping collision and comprehensive would begin to yield a greater net return relative to having a $1,000 deductible.

3. If I can manage to stay accident free for at least 22 months, then dropping collision and comprehensive would begin to yield a greater net return relative to having a $500 deductible.

4. After 30 months, having a $1,000 deducible would reach a break-even point ($0 value). Going forward, it would make sense to drop collision and comprehensive since there would effectively be no benefit.

5. After 36 months, having a $500 deducible would reach a break-even point ($0 value). Again, going forward, it would make sense to drop collision and comprehensive since there would be no benefit.

Consensus

Though I could accumulate some savings over time, the benefit would not outweigh the risk until several months down the road. Clearly paying for a lower deducible would put me in a better position financially, but this is only if I am unlucky and get into an accident. Hence, the higher deductible option seems to fit right into the middle of the road.

Next Worst-Case Scenario: The Other Party Pays the Deductible

Okay, so maybe the situation I painted above isn’t necessarily “typical”. People get into accidents all the time and both parties have insurance. And when they do, that means they also cover your deductible. So is it really fair to base our decision assuming that we’d have so much to lose?

Of course we can take this point into consideration. So let’s re-do our model with one big change: If I’m in an accident, the other party has insurance and ends up paying my full deductible.

With this in mind, how does it change our calculations?

Results

Observations

1. For
the entire life remaining life
of my vehicle, at no point would the net payout with the $500 deductible ever
provide a greater benefit than the $1,000 deductible option.

2. I would need to stay accident
free for at least 30 months for the “dropping collision and
comprehensive” option to yield a greater amount of savings than the $500 deductible option.

3. I would need to stay accident free for at least 34 months for the “dropping collision and comprehensive” option to yield a greater amount of savings than the $1,000 deductible option.

Consensus

Clearly when there is the assumption that I would not have to pay the deductible, it would take much longer for the savings of having no coverage to out-weigh the risk. Also when the deductible is no longer a financial threat, the lower cost, higher deductible choice becomes the better option.

Conclusions

So is it really financially better to drop collision and comprehensive coverage from your auto insurance?

This question really boils down to one thing: Do you believe you’re going to get in an accident or not?

Remember: Insurance is never an investment. Inherenitly, it’s a payment for protection from an unwanted risk.

So on that note, be honest with yourself: What’s the likelihood of this risk? How likely are you to get into accident, either by your own fault or by that of someone else.

Unfortunately, this is probably one of those things where we all tend to feel a somewhat false sense of confidence. Hey, I get it! You’re a safe driver. You could never be the one who gets into the accident, right?

But that’s exactly the problem. An accident doesn’t always have to be “your” fault in order for you to become involved. Accidents sometimes just happen. (That’s why they’re called accidents.)

Just like I mentioned already, my last accident was when someone with no insurance hit my car due to some icy weather. Even though I had her information, since she had no insurance, there was really no way to get her to ever pay for my deducible.

Two years before that, I was in another icy road accident where the car next to me started spinning out of control and hit my car. Again, not my fault. But the next thing I knew I had well over $5,000 in damage to my vehicle.

Every day, I commute to work a long, long ways. I deal with rain, snow, and everything in-between. So like it or not, when I have to really consider how likely I’m ever to be in accident again, the answer is probably “yes”.

Therefore, for me, it would make sense to keep collision and comprehensive coverage, and stick with the lower cost, higher deductible option. In other words, no change from the policy I have currently.

But again: Ask yourself the same question. If you don’t commute or drive in normaly stable weather conditions, then perhaps for you it does make sense to drop collision and compreshieve coverage from your auto policy.

Remember: When it comes to insurance, it’s a gamble. But it’s a high stakes game, so in my opinion, play it safe and choose the conservative option.

Readers – What do you think? When you do think its the right time to drop collision and comprehensive coverage from your auto insurance policy? What factors did you consider, or when do think it makes financial sense?

]]>http://www.mymoneydesign.com/personal-finance-2/insurance-planning/how-do-you-know-when-to-drop-collision-and-comprehensive-coverage/feed/0http://www.mymoneydesign.com/personal-finance-2/insurance-planning/how-do-you-know-when-to-drop-collision-and-comprehensive-coverage/What is the Minimum Retirement Savings You Could Comfortably Live On?http://feedproxy.google.com/~r/MyMoneyDesign/~3/itKytke8OX8/
http://www.mymoneydesign.com/personal-finance-2/retirement/minimum-retirement-savings/#commentsSun, 03 Feb 2019 06:00:37 +0000http://www.mymoneydesign.com/?p=6546Have you ever thought to yourself: What’s the least amount or minimum retirement savings I could get away with? Don’t be bashful about asking it. It’s a perfectly valid question to consider; especially when you think how little retirement savings most people actually have. (In case you’re wondering, its $107,000 for Americans between the ages […]

While the major media outlets would have you believe that you need somewhere between $2 and $3 million dollars, you might be pleasantly surprised to learn that you could possibly become financially independent and consider leaving full-time employment for a whole lot less.

In fact, if there’s one thing I’ve learned from reading the success stories of so many real-life early retirees (some of which you’ll meet in a minute), it’s NOT that you need millions of dollars, insider investment knowledge, or even a big-time high-paying job.

The real trick achieving financial freedom is to simply work on reducing your everyday living expenses.

In this post, I’m going to show you why minimizing your lifestyle costs could be the key to retiring on much, much less retirement savings than you think.

You’ll also get some practical advice for how to reduce a few select expense categories, examining a few areas where you could be potentially saving more, and then look at how much that could possibly shave off of your nest egg target.

How to Calculate the Minimum Retirement Savings You Need

In its simplest form, figuring out how much money you’ll need in order to retire can be reduced down to the following equation:

Your living expenses.

Every solid retirement plan starts with asking the individual: When I retire and no longer have employment income, how much money will I actually need to live on?

Close your eyes for a second and imagine what that life will be like. At the core, there will be your basic expenses for things like:

Housing

Driving

Eating

Medical coverage

Utilities

Taxes

Etc.

But on top of that there will also be “other” flexible expenses for things like:

Hobbies

Entertainment

Travel

Other ways you like to have fun. (… After all, what’s the purpose of retirement if you’re not going to enjoy yourself, right?)

From just one brief look at this equation, we can quickly see: The size of the nest egg you need to save is in direct relation to your living expenses. Therefore, if your goal is to minimize the size of your nest egg, then a good strategy would be to start by simply lowering your living expenses.

For example: Let’s say you believe your living expenses will be $60,000 per year. Using our equation above, you’ll need to save a nest egg of $60,000 x 25 = $1.5 million. But if you can change your habits and live comfortably on $50,000 per year, then you’d only need to save up a nest egg of $1.25 million.

Not sure if that’s really true? In just a minute, I will show you a few examples of some people who have leveraged this living expense – nest egg mathematical relationship to make their financial independence a reality.

The 25X comes from something called the 4 Percent Rule safe withdrawal rate (SWR). This is a widely accepted rule of thumb in financial planning that says you should be able to safely withdraw 4 percent from your nest egg safely every year to cover your living expenses for at least 30 years.

(By the way, if you’re wondering how the number 25 and 4 percent are related, multiplying a number by 25 and dividing it by 4 percent (0.04) is mathematically the same thing.)

On a technical note, there are dozens of factors that could either increase or decrease the safe withdrawal rate you choose. For example,

If you plan to retire very young, you may want to drop your safe withdrawal rate down from 4.0% to 3.5% (or 28.6X). Here is some evidence why.

Or adversely, if you retire when the investment market is under-valued, you might be able to get away with a higher safe withdrawal rate of 4.5% (or 22.2X).

If you really want to know more about the 4 Percent Rule and how to interpret it, feel free to check out this mega-article I wrote here for all the details. For the sake of simplicity, throughout the rest of this article we’ll use the 25X or 4 percent safe withdrawal rate in our examples.

Does This Equation Actually Work – For Real?

Yes! There are lots of real-life examples of early retirees who have reduced their living expenses and been able to successfully retire early using this simple strategy. Here are a few notable ones:

Jacob Fisker from Early Retirement Extreme (both the blog and the book) was able to retire in his early 30’s after get his living expenses down to just approximately $7,000 per year. This allowed him to save nearly 75% of his income and accomplish his goal in just 5 years. If we use the 4 Percent Rule to estimate how much his nest egg was at the time, we can conclude that with such low living expenses he only needed approximately $200,000.

One of my favorite early retirement stories comes from the book“How to Retire Early” by Robert and Robin Charlton. It tells the tale of exactly how (in great detail) the two of them were able to go from almost no savings at all to a nest egg of $1 million in just 15 years by the age of 43! Again, using the 4 Percent Rule, this provides them with roughly $40,000 per year to travel the world and live freely.

After a bad day at work, Carl (age 38) made a vow with his wife Mindy that the two of them would retire in 1500 Days (or 5 years). Hence, they became Mr and Mrs 1500 Days from the blog 1500 Days. The goal was to take their current savings and quickly ramp it up to $1 million target. This was based on an estimation that they would need to cover $30,000 per year in living expenses plus a little extra for their children’s college. Through frugality, a lot of saving, and down-sizing their house, they were actually able to accomplish their goal just 3 years later.

Justin McCurry from Root of Good retired at age 33 after he and his wife reached a savings of just over $1 million. They continue to only spend between $32,000 to $40,000 per year (a little less than 4 percent).

On the far end of the plan, you’re reducing your lifestyle costs which leads to lower needed costs in the future and a lower nest egg total.

But in the present, it also gives the ability to save substantially more of your income each month. You’ll be able to go beyond your peers who save only 10% and work your way up to a more impressive 25% or even 50% savings rate. And as you do, your nest egg will build up more rapidly helping you to reach financial freedom even sooner than might have originally planned.

One good thing really does lead to another!

How to Reduce Your Living Expenses

Okay! So if reducing your living expenses really is the key, the next question we should be asking ourselves is:

How low can we go? What kinds of things could we be doing right now to get our expenses as low as possible so that we would not need so much money for retirement?

Keep in mind that even amounts as low as $500-$1000 per month could translate into hundreds of thousands of dollars less that you need. Here’s a chart you can use to follow:

Therefore, to figure out where we can squeeze, let’s run through some of the typical expense categories and see where we can optimize and improve.

Mortgage:

Killing off your mortgage is one of the most sought-after goals you can achieve in the personal finance community.

Why? Because as you can see from the chart above, eliminating an expense of this size works out to hundreds of thousands of dollars you don’t need to save in the future! Consider if your mortgage is $1,000 per month. By paying off your house and not having this expense any longer, that works out to $300,000 less you need in your nest egg. Not to mention the fact that you can now declare freedom from the mortgage lender and the house is finally all yours!

So what’s the best way to pay down your mortgage?

Send in an extra $100 or $200 per month on top of your principal. Just that little bit extra can knock 5 to 10 years off the typical U.S. mortgage. Use this calculator to find out exactly how many years it could knock off of yours.

Refinance your house from a 30 year to 15 year fixed mortgage. You’ll save a TON in interest and greatly accelerate your payment timeline. I refinanced after one year and saved almost $100 per month.

Consider moving to a more affordable house. Tired of cleaning your 2,500 square foot interior every week? Had enough of mowing your 1 acre lawn? Though it might seem kinda exciting at first to get a big house or car, after a while, it just becomes more work to keep up with – plain and simple! So why not consider down-sizing to something more comfortable with less maintenance? Not only will this likely cut down your mortgage costs, but it will also reduce your household expenses (as well as your time).

Move to some place with lower property costs. I live two county’s away from an area where a house the size of mine could easily cost double what I’m paying right now. Hence why I don’t live there!

Of course keep in mind that your housing costs never truly go down to zero. Even if you do accomplish that wonderful goal of paying off your mortgage, you still have to pay your property taxes and home owners insurance every year.

Vehicles:

Like them or not, vehicles are one of the fastest depreciating things we own. According to The Nest, over the first three years of car ownership, a new car will typically depreciate about 45 percent. Ouch!

The only real way to win financially when it comes to cars is to:

Buy them with cash (or at least finance a portion of them for as little as possible)

Keep up on the maintenance so that they don’t develop bigger, more costly problems

Shop around every two years or so for the best and most affordable auto insurance.

Travel:

Our family loves to travel! And we used to pay between $4,000 – $5,000 to do so … but not anymore! Since 2016, I entered into the world of travel hacking where I now use credit card rewards points to pay for almost every aspect of our travel.

I absolutely can not believe how many great deals are out there for regular people like you and me to take advantage of! Here’s just a taste of the trips we’ve taken and how much we’ve saved:

And we’re no where close to being done. My gears are always turning for the next big trip!

Medical Insurance:

This is the tricky one. It seems like every time you turn on the news there is always some new debate about how and when medical care coverage will change.

Regardless, there will most likely be some cost associated with this topic. But remember: If you’re 65 or older, you can file for Medicare. If you’re younger than that, then check out this page for ideas on where to find good coverage.

Power / Heating:

Keeping an eye on the thermostat and not running the heat or air conditioner all the time are your best bets here. If you don’t already have one, install a programmable thermostat and set it so that you don’t use heating or cooling while you’re away at work or school. You can also lower the temperature a few degrees at night while you’re sleeping.

In addition, don’t use electric space heaters or gas fireplaces excessively since they will also drive up your power consumption costs.

Side note: Moving to a smaller house is one sure way to reduce your energy costs!

Phones:

An inexpensive family cell phone plan can be purchased these days for less than $100 per month. It can be even lower than that if you don’t upgrade your phone every time a new one comes out.

If you really want to get frugal, FaceTime Video / Audio and other WiFi calling options are free over your Internet connection.

TV / Internet:

Traditional cable is a thing of the past …

Ditch it and step into the future with the world of streaming TV instead.

What’s that? It’s where you use your internet connection to watch local and regular TV channels as well as movies and other premium shows (through Netflix, Amazon Prime, YouTube, or any number of cool apps).

We made the switch and have been saving a TON of money on cable ever since! Plus, we have more options to choose from!

What do you need to get started? For starters, a TV and a reliable Internet connection. If your TV is already Wi-Fi ready, then lots of these apps will already be available to you. But there are also any number of inexpensive streaming devices that can help you to do the job. Click here to read more about it.

Food:

When it comes to groceries, the key here is planning. If you throw things away every week, then something is wrong. Sit down and make a list of all the meals you’re going to make. Then go out and buy only those items that you need.

As for eating out, keep it to once per week. Set a limit for yourself; such as no more than $10-15 per person. Order a sandwich instead of an entree, and water instead of a soft-drink. Also consider foods that you can share, such as pizza or a family size salad!

Entertainment:

Being entertained doesn’t always have to mean spending money. Some of my favorite times are when we go for walks, play a sport with the kids, exercise, or do a local activity within our community.

Are There Other Ways to Retire on Even Less Savings?

Yes!

So far we’ve only assumed that all of your retirement income is coming straight from your nest egg. But that’s not always necessarily the case.

In reality, your retirement income could come from any variety of sources. As long as its reliable, then it means you could shave your nest egg down even further.

Example:

Let’s say you believe your retirement income will be $40,000 per year. But you’ve got other sources of income that will provide a steady, reliable $10,000 per year. Now your nest egg target only needs to be $30,000 x 25 = $750,000.

Great! So now we have another variable we can add to our equation that will reduce our retirement savings down even further.

But what might these other source of income be?

Part-Time Employment:

Just because you’re “retired” doesn’t mean you have to sit on your butt and never work again.

Perhaps you worked in an office most of your career, but you really loved playing music. Maybe now in retirement you could teach music on the side!

That’s the beauty of retirement. You CAN work if you want to – especially doing something in a field that you really enjoy. And if that part-time work produces even just a little bit of extra income, that can have a really powerful reduction on your retirement savings needs.

Social Security:

Are you expecting to receive Social Security right around the time you plan to retire? If so, let’s say that you plan to need $4,000 per month for living expenses and $1,000 per month will come from Social Security. In that case, your retirement savings only needs to produce $4,000 – $1,000 = $3,000 each month (or $36,000 per year). That drops our retirement savings target down from $120,000 to $900,000; a reduction of $300,000!

Other ways to make money on the side:

Additional retirement income could come from any number of legitimate sources. Another common example are folks who own rental properties. Again: $500 in net rental income could equal out to $150,000 LESS that you need to save for retirement!

In this book, we cover the topic of retirement planning from a variety of angles. We’ll look at everything from reducing your living expenses to how safe withdrawal rates can be leveraged to help you need less savings.

Regardless, the take-away should be clear. If you truly want to be financially independent, don’t chase after the illusions of earning as much as a VP or becoming some kind of investment wizard. These are talents acquired by only a very select minority of the population.

For the majority, there is a much, much more attainable goal sitting right in front of you. If you learn how to do more with less, then financial freedom is an option at any income level. The math works out the same whether you are a high income or low income earner.

The challenge, however, is all in how you get there. Just like taking care of our bodies and becoming more healthy, exercising some discipline when it comes to our spending is the first step to a successful path towards financial independence. Master this and you will have overcome the hardest part of the journey!

Readers – What’s the least amount of money you believe you could comfortably live off of? How much does this reduce your retirement savings goal by?

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/minimum-retirement-savings/feed/40http://www.mymoneydesign.com/personal-finance-2/retirement/minimum-retirement-savings/Never Underestimate the Value of Knowledgehttp://feedproxy.google.com/~r/MyMoneyDesign/~3/wKZYwtzIttA/
http://www.mymoneydesign.com/lifestyle/philosophy-motivation/the-value-of-knowledge/#respondSun, 27 Jan 2019 06:00:22 +0000http://www.mymoneydesign.com/?p=10995As humans, we tend to value a lot of different qualities and abilities in ourselves. But when it comes to appreciating the value of knowledge, this is one asset we tend to underestimate. Consider this: Would you say you’re an “expert” at something? Don’t be too humble. According to the author Malcolm Gladwell, author of […]

As humans, we tend to value a lot of different qualities and abilities in ourselves. But when it comes to appreciating the value of knowledge, this is one asset we tend to underestimate.

Consider this: Would you say you’re an “expert” at something?

Don’t be too humble. According to the author Malcolm Gladwell, author of the incredible book “Outliers”, it takes at least 10,000 hours to become a master at something. While that might sound like a crazy amount of time to invest into something, chances are that you may have already put that much time into your favorite hobby or interest.

Perhaps you have knowledge or skills that are the by-product of your day job. And even if its not the most interesting topic, if someone were to ask you a question about your particular specialty, you’d probably be able to impress them with the volume of information you have readily available at the tip of your tongue.

Whether you realize it or not, the value of knowledge is something which can be leveraged. When applied in a way that helps others, the things we “know” could be exchanged for a handsome fee, used to advance our careers, and ultimately lead to actions that will bring us closer to achieving financial freedom.

To take this asset for granted would be just as silly as applying for a job and forgetting to mention that you have a 4-year college degree. The knowledge you have isn’t something you’re born with. It’s acquired over time. It’s earned. You’ve put effort towards gaining it. And all of that should mean something.

So now the only question is: How can you turn that effort into something positive financially? Something tangible that can change your life?

Don’t believe me that such a thing is real? One of my favorite lessons in the value of knowledge is “The Story of the Repairman”. Here’s how it goes:

The Story of the Repairman

A large factory is producing hundreds of thousands of dollars of goods.

One day, a critical machine in the line goes down. The boss is frantic! “We can’t stop production! We’ve got orders to fill! Call a repairman at once!”

So the factory calls a local repairman to fix the machine. The repairman says takes a look at the situation and tells them it will cost $5,000 to fix the machine. In haste, the factory boss agrees.

The repairman then opens up his tool-bag and starts going over the machine. He spends a few minutes looking underneath it and checking the gauges. Then he takes out his wrench and begins to tap on the machine. After about 15 minutes of tapping in various spots, the machine starts to work again. The repairman, acknowledging a job well done, packs up his wrench and is off.

A week later the invoice for $5,000 shows up at the factory. It goes to the boss’s desk for approval, and he hesitates. “The man was only here for 15 minutes! How can he possibly think he can charge us this much money?”

So the factory boss calls the repairman and asks him if he could be so kind as to itemize the invoice. About an hour, the repairman emails over an itemized copy of the invoice. It reads as follows:

Line Item 1 – $100 – One hour of labor

Line Item 2 – $4,900 – Knowing where to tap on the machine with the wrench.

Although he is reluctant, the factory boss remembers that he was given the price up-front. And when he thinks about how much money they would lost if the factory had been shut down all day, it would have been substantially more by comparison. So in realizing the value that the repairman provided, he approves the invoice for payment.

Leveraging the Value of Knowledge

So what do we learn from this? What is the the moral of the story?

(… No, it’s not that you should try to rip-off your customers and get as much money out them as possible …)

This light-hearted story is meant to teach us one thing: Value is in the eye of the beholder. What you know or find to be common-knowledge might be complex to others. Knowledge is relative; it’s a matter of perception, and the more you seem to have of what people want (or need), the better your opportunities for financial gain will be.

The story of the repairman happens all the time. Sometimes it happens “literally” with real repairmen. Think about the last time your refrigerator or washing machine wasn’t working quite right, and you needed some help. Like the factory boss, your options are to buy a whole new appliance (a thousand dollars or more) or to pay the repairman whatever rate he quotes you (usually a few hundred dollars). Which would you rather pay?

A “repairman” could also be someone with the knowledge to fix … just about anything! Think about how many people there are in the world who are able to call themselves (or be known by others as) experts or gurus. (Also think about how they are able to command compensation beyond our normal realm of comprehension!)

Maybe you know someone who has hired personal trainer, financial coach, career coach, or even life coach. In all of these areas, the expert needs to have intricate knowledge of the field and be able to apply it in a practical way that will best help their client.

Maybe you know of a company or employer who paid outside consultants several tens (maybe hundreds) of thousands of dollars to give them advice about a particular subject.

How can these experts often demand fees and rates that seem substantially higher than what you or I would earn per hour from our regular job? Because the value they are perceived to provide transcends the traditional dollar-per-hour work model. Often times, they aren’t even being billed for the number of hours they’re working. Instead, they’re being paid a handsome flat fee or commission.

Why are they able to do this? Because fundamentally they have something you need. They have knowledge that could help you and your company to succeed and turn results that are several multiples higher than the fee they are asking to charge. They create value with their knowledge, and financially they know that they can leverage it just the same as any other tangible asset.

What Do You Know That Would Be Worth Something to Someone Else?

Do you have any skills or abilities where you could do the same thing? Do you know anything that you believe someone would be willing to pay you to find out more about? For example, could you:

Write freelance articles, blog posts, or even author an ebook about a particular topic?

Coach someone to be more successful with their job, fitness goals, personal finance, musical instrument, etc.?

Act as a consultant for modern advertising through social media?

You might doubt yourself. But I’m sure that if you really dove into one of your special interests or hobbies, you might find out that you have a lot more to offer to someone than you think!

Invest In Your Knowledge

Do you lack confidence in your mastery of a subject? Don’t feel like you have the right credibility? Want to sharpen your knowledge all around?

If any of these doubts sound familiar to you to, then perhaps you need to invest more in your own knowledge. For example, you might it would be beneficial to:

Go back to college to get your bachelor’s or even masters degree.

Get certified in a particular field (such as becoming Certified Financial Planner).

Go to a seminar to learn more about a possible business venture (i.e. real estate, house flipping).

Take an online class to learn how to better market your digital skills. Bloggers do this all the time to find out more about they can attract more readers and promote their content better.

Purchase one-on-one fitness training to reach your health goals.

There are so many more we could list!

Value Doesn’t Always Have to Mean “Money”

Remember: Sometimes “getting paid” for what you know ISN’T always the ultimate goal. Often the knowledge we gain could be leveraged to make significant improvements in our lives – beyond the value of money.

Think about a person who invests their time and energy into eating healthier, losing weight, and exercising. Given the scenarios I gave above, maybe this person could consider becoming a personal trainer or even a life coach.

But think about the changes this person could make in their own life (or the lives of their family and friends). Learning what healthy habits to take on and what exercises to engage in will undoubtedly add years and years of quality to this person (not to mention minimize your medical issues).

When I think about myself and all the knowledge I’ve acquired throughout the years about personal finance, its the same thing. Yes, I make money with my writing. Yes, I could likely even be paid for helping others with their money issues. But what’s the most incredible to me is how much this knowledge has improved the financial situation in my own household. Thanks to these efforts, we’re able to buy pretty much whatever we want when we want. We’ve traveled to exotic locations most people only see in magazines. And most importantly, we’ll likely retire early about 20 years before most of my peers. That’s power. That’s truly the value of knowledge, and I’m happy to be living it.

Readers – How do you leverage the value of knowledge to your benefit? What kind of an impact or improvement has it made on your finances, career, or personal life?

Related posts:

]]>http://www.mymoneydesign.com/lifestyle/philosophy-motivation/the-value-of-knowledge/feed/0http://www.mymoneydesign.com/lifestyle/philosophy-motivation/the-value-of-knowledge/How To Maximize Your 401(k) Contributionhttp://feedproxy.google.com/~r/MyMoneyDesign/~3/tJhzdMZvpao/
http://www.mymoneydesign.com/personal-finance-2/retirement/how-to-maximize-your-401k-contribution/#respondSun, 20 Jan 2019 06:00:23 +0000http://www.mymoneydesign.com/?p=10959Are you wondering how to maximize your 401(k) contribution without feeling like you won’t have any money leftover to spend? Hey, I get it! When I was just starting out as a young professional, I started off by contributing what I thought was a decent amount to my 401(k) retirement plan (10 percent or so) … […]

Are you wondering how to maximize your 401(k) contribution without feeling like you won’t have any money leftover to spend?

Hey, I get it! When I was just starting out as a young professional, I started off by contributing what I thought was a decent amount to my 401(k) retirement plan (10 percent or so) …

But as we started really defining how much money we’d eventually need to retire, especially as our goal timeline transitioned from our 60’s down to our 40’s, it quickly became apparent that our savings rate wasn’t enough. If we were going to retire early successfully, then we were going to need to substantially bump up our 401(k) contributions. And by A LOT!

So how do you do that? Let’s be real … you only make a fixed amount of money each year. Where is this “extra” money supposed to come from? And how can you stay disciplined enough to not use this future savings for all of the bills and expenses that you’ve got to deal with “now” in the present?

Maybe this is why it’s been stated that over half (51%) of Americans aren’t contributing anything at all to their employer sponsored retirement plan (according to Forbes).

Well, I’m here to tell you that there’s hope! There’s a very simple way to maximize your 401(k) contributions without breaking your household budget or feeling like you have to live off of a fraction of your income.

It’s called the 401(k) raise ratchet method, and I can personally tell you that it was a very painless way for me to increase my retirement savings – all the way up until I reached the IRS annual maximum contribution limit. In fact, this method was so effective, we used it not just to increase my savings rate, but also that of my wife and our two IRA’s!

Want to see how it works? Okay … but first let’s get a better understanding of why we’ll be focusing on your 401(k) plan rather than other traditional savings options.

Why Focus on Your 401(k)?

What is it that makes saving your money in a 401(k) plan different from other ways you could be saving? Why aren’t we focused on building up a traditional bank account or investment portfolio (outside of your retirement plan)?

For two BIG reasons …

1- You Effectively Save More Money By Avoiding Taxes

Unlike traditional saving and investment accounts, a traditional 401(k), 403(b), or thrift plan (depending on where you work), is tax-deferred. This means you save your money BEFORE the taxes are taken out.

Think of it this way. When the average person thinks about saving their money, it’s often with money from their paycheck – money that they’ve paid taxes on. This means that, in reality, every dollar they earned is really only worth about 78 cents because the other 22 cents went to the government in the form of taxes.

This is where saving your money in a 401(k) can be a huge advantage! When you save money tax-deferred, every dollar earned is a dollar you could be saving for yourself. Nothing is passed on to taxes! Now you’re effectively saving an extra 28% more than if you were to try to save your money after taxes.

That’s not a point to be taken lightly. Let’s say you use this raise ratchet method and you’re able to save all the way up to the IRS maximum limit of $19,000. Do this and now you’re stashing away an extra +$5,000 more that would have otherwise went to the government. That’s a lot of extra money just for simply being smart about how and where you choose to grow your nest egg!

2- Getting Free Money From Employer Matching

The other big reason to focus on maximizing your 401(k) contributions before other savings options: 401(k) employer matching contributions.

What are 401(k) matching contributions? It’s FREE money your employer gives you simply for participating in their 401(k) plan!

According to the Bureau of Labor Statistics, 51% of employers in the U.S. will match some percentage of the amount of money you contribute to your 401(k) plan. That means on average you could be earning an extra 3.5% of your salary – all for just being responsible and putting it away for retirement someday.

When I used to manage several employees, I was always amazed at how many people ignored this point (or simply didn’t care). To me, it was a very simple deal: The more money you contribute, the more FREE money they give you!

How to Increase Your 401(k) Contributions Using the Raise Ratchet Method

So what exactly is the 401(k) raise ratchet and how does it help you to contribute the maximum to your 401(k)?

Simple. When you get a raise from your employer, simply take the increase amount and divide it in half. Next, increase your 401(k) contribution by whatever this amount of money is. Then repeat every time you get another raise or pay increase.

Do this enough times year after year, and eventually you’ll find yourself contributing all the way up to the full IRS maximum amount you’re allowed to make to your 401(k).

Example

Let’s say you currently earn $50,000 per year and contribute
10% to your 401(k) ($5,000 per year).

Your employer gives you a 4% increase for the year = $2,000.

Take half of this raise amount ($1,000) and increase your 401(k)
contribution to $6,000 total.

Great! Now you will be able to enjoy both having more
disposable income as well as the responsible act of saving more for retirement.

Why Does the 401(k) Raise Ratchet Method Work?

The 401(k) raise ratchet method works because it doesn’t intrude upon your current budget. Strategically, you’re making contribution increases right at the moment when you’re least likely to “feel” them – when your income goes up!

According to USA Today, one of the big excuses why more people don’t participate or contribute more money into their 401(k) plans is because they say it cuts into their other “financial priorities”. This could be anything from a legit savings goal (i.e. a new home) to completely unnecessary spending habits such as a splurge at the mall. Either way, it’s a pain that most people would much rather simply avoid!

This is why waiting until you receive a raise or pay
increase is the perfect time to make the switch. The effect you’d feel would be
seamless.

Think about it. You’re in a transition from a point where
you were OK with money to where you have more. So do you really need the extra
income? To be as comfortable as the year before, probably not. If you can keep
lifestyle creep at bay (the act of simply spending more money freely because
you have more), then you’re likely to get along just fine on approximately
whatever you spent last year.

But you might say: I earned that raise! Why should I not get to enjoy it?

And this is why I’d say start with only deferring “half”. By only diverting half of your raise towards increasing your 401(k) contribution, you get the best of both worlds – a seamless bump in your retirement savings as well as a few extra dollars to spend every paycheck.

Who says you can’t have your cake and eat it too!

How to Reach the 401(k) Max Even Faster

How badly do you want to reach financial freedom? Do you not want to wait several years until you’re contributing the IRS 401(k) maximum?

If so, then make this simple adjustment: To really accelerate your savings, increase your 401(k) contribution by 100% of raise instead of just half.

Again, the same logic applies (just on a slightly more restrictive scale). You were probably living just fine on whatever income level you earned last year, and will be able to continue to do so going forward. Though it would be fun to enjoy a little extra money, there’s no reason you absolutely have to. And since it’s going into your retirement nest egg, you know you’re doing something sensible with it.

Diverting 100% of our raises was actually the strategy we used for years to ratchet up our retirement contributions all the way up to the max. By not allowing lifestyle inflation to creep in (i.e. spending more because you have more money) and staying disciplined to our budget, most years we barely even noticed that we were diverting our raise towards this goal. And then before you knew it, we found ourselves all the way up to the maximum IRS limit.

What About My IRA?

Does your 401(k) have fees or poor investment choices? (You can use a free service such as this 401(k) fee analyzer to see how your plan compares.)

If so, then you don’t have to let that derail your savings efforts. Instead of putting your additional earnings towards your 401(k), simply put them into an IRA instead.

IRA’s are more or less similar to 401(k) plans in how they are used to help build your retirement nest egg and avoid taxes. The major difference is that an IRA is a plan setup by yourself rather than through your employer (see all the differences between an IRA vs 401(k) plan here).

Realistically, if you don’t feel comfortable with your 401(k) plan, then you can use the same strategy above to contribute more money to your IRA instead. (For a road-map of what questions to consider, please check out this post first.)

If you’d like to be really aggressive with your savings rate,
you can use the raise ratchet method to keep making contribution increases
until you reach the IRS threshold for both.

Again … Get Free Money From Your Employer!

I know we already talked about employer 401(k) matching contributions already. But it’s a point I feel so strongly about, that I’m going to say it again …

No matter what your contribution level is today or where you want it to be in the future, be sure to contribute enough to get your full 401(k) employer match! If you don’t, you’re simply passing up the chance to get free money with every paycheck.

The best way to approach this is to check with your HR
department and get the facts. Find out (preferably in writing) how much your
employer matches and what you have to do to get every last cent.

Seriously, don’t wait to use the raise ratchet. If you’re missing out on free money, act now! Take a hard look at your spending habits and adjust your budget as needed.

Don’t Try to Time the Market

Perhaps you’re fine to increase your contributions, but some recent dips in the stock market have got you scared that any money you’re putting into your retirement account is more or less being thrown away. Should you instead try to wait out the market turbulence before you increase your 401(k) contributions?

No! Unfortunately no one ever knows if the market is going to go up or down the next day, next month, or even a year from now. For this reason, we can’t “time the market”, and therefore the best policy is just to simply raise your contributions whenever you’re ready to do so.

Legendary billionaire J.P. Morgan was once asked “what will the market do tomorrow?” His classically famous answer: It will fluctuate. In other words, no one can predict whether we are at a peak or at the bottom, not even billionaire investors. So how could you ever expect to?

This was one my personal biggest mistakes back during the
Great Recession starting in 2008. I received a nice company bonus but didn’t
want to put any of it into investments after watching the market fall by nearly
half.

In hindsight, this actually would have been the greatest
time in my investment history because stocks were so cheap! A year later after
stocks started to creep back up, I could have had double digit returns!

Oh well, you live and you learn.

But Don’t I Have to Wait Until Age 59-1/2 to Get My 401(k) Savings?

Yes … and no.

The IRS does state that you have to wait until age 59-1/2 to be able to gain access to your 401(k) retirement savings without penalty.

But early retirement seekers have found numerous ways around this rule. There are thousands of stories online of people in their 40’s and 50’s happily living off of their retirement savings. It’s a topic I wanted to explore myself, and I even ended up writing a whole book about it.

Saving Beyond the IRS Maximum Limit

Have you increased your 401(k) contributions all the way up to the IRS maximum and would like to keep going?

It’s not very well known, but the IRS does allow you to make after-tax contributions to your 401(k) plan (up to a certain limit). Unfortunately you would have to pay taxes on these contributions up front. But the good news is that they would grow earnings inside your retirement plan that are tax-deferred. The only catch is that your employer’s 401(k) plan has to allow for you to do this.

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/how-to-maximize-your-401k-contribution/feed/0http://www.mymoneydesign.com/personal-finance-2/retirement/how-to-maximize-your-401k-contribution/Should I Pay Off My Mortgage Early or Not?http://feedproxy.google.com/~r/MyMoneyDesign/~3/Xw4nXuiwCJc/
http://www.mymoneydesign.com/personal-finance-2/mortgage-refinance/should-i-pay-off-my-mortgage-early/#commentsSat, 12 Jan 2019 06:00:00 +0000http://www.mymoneydesign.com/?p=3419Which is really the better option – Should I pay off my mortgage early, or look for higher yielding ways to use my money responsibly (like investing it, paying down down debt, etc.)? It’s a financially responsible question I believe most people ask themselves at some point; especially when they find themselves with some extra cash […]

]]>Which is really the better option – Should I pay off my mortgage early, or look for higher yielding ways to use my money responsibly (like investing it, paying down down debt, etc.)?

It’s a financially responsible question I believe most people ask themselves at some point; especially when they find themselves with some extra cash that they’d like to put to good use. More than once after my wife and I have found ourselves with a new raise or bonus, we’ve questioned whether it would smart to use that extra cash to pay off some additional mortgage principal every month.

Why is that? Because eliminating your monthly mortgage payment has classically been accepted as almost a sort of “pre-requirement” to achieving financial independence. ABC’s “Shark Tank” co-host and personal finance author Kevin O’Leary has been quoted as saying “If you want to find financial freedom, you need to retire all debt — and yes that includes your mortgage,”according to CNBC.

And he’s not alone in his advice. Completely paying down your mortgage debt has been a sentiment shared by popular financial gurus, advisers, and those approaching retirement for decades.

Even those seeking early retirement have made paying off their mortgages a top priority. Read the stories of dozens of early retirees across the Internet, and you’ll quickly recognize that eliminating their mortgage debt was a huge component in reducing the amount of money they needed to accomplish their goal.

But then consider that we’ve all been in a very unique place in history in terms of interest rates. Up until 2016, the U.S. Federal Reserve has held interest rates at nearly 0 for almost 6 years (in an attempt to try to stabilize the economy). This means nearly anyone who got a new mortgage or refinanced within the past decade could be paying between 3 and 5 percent interest.

If you’re one of these people who was able to lock into a rate so low, does it then make sense to pay off your mortgage early when there could be better opportunities for you to use or grow your money?

In this post, we’ll look at both sides of the early mortgage payoff argument and weigh the pros and cons. In the end, you can consider which points will help you the most, and what you think would be the best use of your money!

Why You Should Pay Your Mortgage Off Early

Some people get extremely passionate when it comes to idea of paying off your mortgage early. And for several good reasons!

1. That feeling of finally being DEBT FREE!

When it comes to your finances, there is no better feeling than that of being “debt free”.

Say it with me … “debt free” ….

Imagine waking up and saying to yourself: I don’t owe anyone anything! I could lose my job tomorrow, and it wouldn’t matter. I’ve done what was needed to protect the greatest asset that my family and I depend on. The house and everything in it will still be mine – all because I paid it off!

This simple but powerful psychological reason is one that has driven many people to accelerate their house payments at incredible rates. Just like a career or weight loss goal, they simply want to be able to say “This house is mine! I own it and no one can take it away!”

Who can blame them? Wouldn’t it just feel great not to see that huge mortgage payment deducted from your checking account every month?

2. Saving yourself thousands of dollars in interest.

Now we get to the technical reason …

The definition of a mortgage is that it is a loan. Loans carry interest. When it comes to interest, there are only two sides:

Those who pay interest.

Those who receive interest.

Unfortunately, since none of us are lenders, we’re all on the wrong side of that equation! And the longer you carry your mortgage, the more interest you’ll end up paying to the lender over time. Who wants to do that?

Fortunately, mortgages are designed in a way that can exploited, and the way to do it is simple. The sooner you payoff the principal, the less money in interest you’ll pay over time!

The savings are not trivial! For example, something as small as $100 extra dollars per month could end up saving you over $20,000 in interest payments over time! And that’s not to mention shaving almost 5 years off your payment schedule.

Want to see for yourself? Try this free calculator from BankRate. I highly encourage you to test it out and see just how much interest you end up paying on your house over the life of your mortgage. It can be extremely eye opening!

3. Building up equity

Unlike when you rent, every portion of your mortgage payment that goes towards the principal builds up “equity”. Technically, this is the amount of the asset (your house) that you officially own.

Why does that matter? Because when you go to sell your house, you’re entitled to this equity, which could mean tens or even hundreds of thousands of dollars!

Let me tell you – when we sold our house, it was pretty nice getting a big fat check for over $30,000! Depending on what your next move is in life after you sell your house, you could really use this money for a variety of reasons:

Next mortgage down payment

Payoff debt

Finance a portion of your retirement

Effectively, you could almost think of it like paying your future self!

4. Locking into a fixed return rate.

Not a lot of people realize it, but paying down long term debt is just about the same thing as investing it.

How so? Let’s take your mortgage, for example. When you pay down your mortgage early, it’s the equivalent of investing that money and getting the same rate of return. If your mortgage APR is 5%, then for every dollar extra you put down on the principal, you’re effectively saving 5% in interest. (For an in-depth explanation of how that works, read my post Which is Better – Paying Off Your Mortgage or Investing the Money?)

Given our historically low interest rates over the past decade, and for some people this might be a more lucrative rate of return. When was the last time you went to a bank and were offered a CD with a fixed rate of 5.0%?

Why not just invest in stocks for a higher rate of return? Well … you could, and that’s one of the points we’ll discuss further in the next section. But keep in mind: Paying off debt is like getting a “guaranteed” rate of return (the same as a bank savings account or CD). Stocks are not guaranteed, and there is therefore more risk involved.

5. Reducing the amount of money you’ll need later or during retirement.

There’s a very good reason why so many financial guru’s and enthusiasts tell you to get rid of your house payment before you consider retirement. Eliminating your mortgage payment dramatically reduces how much money you’ll need in order to retire.

For example, let’s say you have a $1,000 mortgage payment and $4,000 in expenses. In the classic calculation, you’d need $5,000 x 12 months = $60,000 per year which equates to a retirement savings target of $1,500,000. But if your mortgage was completely paid off, then you’d only have to cover $4,000 in expenses. This means you’d only need $48,000 per year, which works out to a target nest egg of $1,200,000 instead; a difference of $300,000 less!

6. Lower taxable retirement income.

Again, thinking ahead to retirement, if you’re smart about how much taxes you’d like to pay when you’re retired, then you’ll want to make sure you pay off your mortgage before you enter into retirement.

The reason is this: When you retire, you’ll want to withdraw as little money as possible from your nest egg and Social Security so that you pay little to no taxes.

Suppose for retirement you decide you’ll need $30,000 per year pre-tax. Now let’s say that $10,000 of that $30K are your mortgage payments. If your mortgage was paid off, wouldn’t it be better to only need $20K instead of $30K. At $20,000, you’d actually owe no Federal taxes whereas at $30,000 you’d owe something.

Of course there are many ways to dance around paying taxes altogether during retirement, and this could be a complete non-issue. If you’re interested in knowing more about this, check out my how to have a tax free retirement. We actually worked out a scenario where you could withdraw $132,500 from your nest egg without paying any taxes at all!

Why You Should Not Pay Off Your Mortgage Early

While each of the above reasons above were pretty good, the reasons NOT to pay down your mortgage ahead of schedule can also be just as equally enticing.

1. Hedging inflation.

If you have a fixed rate mortgage, then your principal and interest payments will be the same for the next 15 or 30 years (depending on whatever kind of mortgage you took out).

While that may not sound very special, it actually has a very unique benefit to you in terms of inflation protection.
Consider this: As time goes on, all your other monthly payments will go up like your food, gas, utilities, car payments, insurance costs, etc, will go up.

But not your mortgage. Your mortgage is frozen in time. And relative to everything else you’re buying, that payment will actually “feel” like less the longer time carries on.

For example, let’s say you’re paying $800 today for principal and interest. For as long as you have the loan and do not refinance, you’ll always pay $800 every month. So if inflation increases by an average of 3% every year, that $800 will “feel” like the following over time:

Your future self might appreciate this!

2. Find a Better Rate of Return

Above we said that making a mortgage payment is basically the same thing as getting an investment with the same return rate. So let’s suppose that you refinanced your mortgage within the last year and got a fixed rate at 4.0%. If the average annualized return of the stock market (such as the S&P 500 index) is 8.0%, then that’s a difference of 8.0% – 4.0% = 4.0%. If you’re investing for the long haul, then rather than paying off your mortgage early, why not go for the market average and shoot for an 8% return instead of a 4% one?

3. Inability to tap into the funds due to loss of equity

What if we have another Great Recession like we had in 2008 and house values don’t go back to where they once were? What if they drop even further?

While debt is debt and you’ll have to pay off your mortgage no matter what your house value is, it may not strategically make sense to “park” your money in your house by paying your mortgage off early.

Consider if you made extra payments towards your house and you suddenly had to move for some reason. What if your house unfortunately sold for less than what you still owe on it? You’d never recover all that money you paid into your mortgage, and so you’d be out. According to this story from ABC News, this is unfortunately exactly the kind of thing that happened to one couple when they decided to use their 401k retirement funds to pay off their mortgage rather than waiting.

A better place may be to temporarily park your extra cash in an emergency fund or someplace where you can have access to it in case something came up.

4. Low interest rates.

When I refinanced my house a few years ago, I thought I’d never see interest rates that low ever again. Imagine my surprise when rates continued to fluctuate and banks were offering 15 year loans as low as 2.75%. Could you imagine a mortgage with a rate as low as 2.75%? That’s less than the average 3% inflation rate.

If you were lucky enough to lock into one of these ultra low rates, then you’re basically paying a historical low of almost next to nothing for your mortgage.

5. Fewer income tax return breaks.

You may not realize it, but your mortgage interest is deductible against your U.S. income taxes. Most other forms of debt (like a credit card or car payment) are not. While there is always a Standard Deduction, in some situations it may work out better for your tax situation to have more interest to declare.

Unfortunately this point can be somewhat weak in the pay off your mortgage early debate. Suppose you own a median priced house with around 20% equity in the house. In that instance the IRS Standard Deduction would automatically exceed whatever tax benefit you’d receive from itemizing.

6.Taking Care of Other financial goals.

Foregoing putting money into your 401k?

Not stuffing your emergency fund with the cash it needs?

Do you have high interest debt you should be paying off instead?

Maybe relative to these things paying off your house early just isn’t a huge priority.

What is the Right Answer?

So after all of that, you’re probably wondering to yourself which of these directions is the right one to go in.

The short answer – it depends entirely on you.

Only you know your own financial well being. Perhaps some of the points we made here carry more weight to you than others. Regardless, there is never really a good one-size-fits-all answer to these kinds of situations. All you can do is look at the possibilities and decide for yourself which ones fit your position the best.

Readers – What do you think? Have you ever given much thought to the question of should I pay off my mortgage early? Did you end up doing it? Or did you find other reasons why you should do something else with the money?

Related posts:

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http://www.mymoneydesign.com/personal-finance-2/retirement/how-much-should-i-contribute-to-my-401k-plan/#commentsSun, 06 Jan 2019 06:00:10 +0000http://www.mymoneydesign.com/?p=7984How much should I contribute to my 401(k) plan each year? While some say 10-15%, hit this one number and you'll save over $4,000 in taxes every year!

]]>If there’s one question about retirement planning that many people feel unsure about, it’s this: How much should I contribute to my 401(k) each year?

Seriously … what’s the magic answer? Is it 5%? 10%? 15%?

Take a stroll around the Internet, and you’re bound to find a number of opinions from reputable sites. For example, Investopedia is quoted as saying that “a good sweet spot is between 10% to 15%”.

That’s not surprising; especially when you consider that when you’re young (in your 20’s and 30’s) and just starting out, retirement can feel like such a long ways away.

You know you should be saving up for the future. But at the same time you’ve got to balance your finances against goals that are in the present such as your family needs, housing, vehicles, etc. And so 10% to 15% seems like a good compromise. (… The only problem is that we tend to contribute much less than that; 6.2% according to Vanguard.)

While all of this may be fine and good, I believe that if more people were to look at contributing to their 401(k) accounts the way that I’m about to show you, then they would be saving a WHOLE LOT MORE!

As you’ll see, it’s a grand opportunity to take advantage of some major, major savings.

This is why when people ask how much they should be contributing to their 401(k)’s, my answer is simple: Contribute the max!

Why You Should Contribute as Much as Possible and Max Out Your 401(k)

Let me ask you a question: Do you like to buy stuff when it’s:

Full price or

On sale?

I think most of us would agree that “On Sale” is the way to go! And if you’re anything like me, then you LOVE getting a good deal on something you were planning to buy anyways.

Well, believe it or not, this simple analogy applies to your retirement savings too. You have the option to either:

Save a portion of your paycheck in a regular bank account.

Save a MUCH LARGER portion of your paycheck without any extra effort using your 401(k)!

How is that possible?

Simple … by legally avoiding paying TAXES!

But what’s even more interesting is that this savings can be scaled! The more money you decide to put in your 401(k), the more money that you end up saving! Therefore, it would make sense to bump your contribution rate up as high as possible!

Let’s break this down using a single dollar as an example …

Saving 28% More of Your Money

For every dollar you earn, you know that you must pay taxes on it.

Using the Federal average tax rate of 22%, this means that:

For every $1.00 earned,

Roughly $0.22 goes to taxes and

Roughly $0.78 is leftover for you to save, spend, … do with as you please.

This means that if you simply put your money in a bank account after taxes are paid, for every $1 you had hoped to save, you’re really only saving $0.78 of it.

That’s NOT a very good deal.

Now let’s look at how this works when we use a 401(k) instead:

For every $1.00 earned,

$0 goes to taxes. Remember that with a 401(k), you get to defer your taxes for decades later into the future until you are finally withdraw the money.

Therefore, the whole $1.00 gets saved!

This is the fundamental benefit of using a 401(k) to save for retirement. You get to keep both the $0.78 you would have saved PLUS the $0.22 you would have paid towards taxes!

Which would you rather have available to save: $0.78 or $1.00?

Clearly being able to save the $1.00 using a 401(k) is the better choice! That’s roughly ($1 – $0.78) / $0.78 = 28% more for doing nothing more than being smart about how you save your money!

So, now that you understand how tax-advantaged savings with a 401(k) works, how can you use this information to get the MAXIMUM amount of benefit?

As I said before: MAX out your savings; all the way up to the IRS contribution limit!

How Saving the IRS Max = +$4,000 Saved!

Let’s reach for the stars for a minute and consider what the benefit would be if you contributed enough money to your 401(k) to hit this upper limit.

Using the same numbers as our previous example, we now have:

$19,000 is earned,

$19,000 x 22% = $4,180 goes to taxes and

$14,820 is leftover for you to save.

But again, by saving our money using our 401(k):

$19,000 is earned.

$0 goes to taxes. (Taxes are deferred.)

Therefore, the whole $19,000 gets saved!

Again, by using your 401(k), you get to keep both the $14,820 you would have saved PLUS the $4,180 you would have paid towards taxes!

How many other strategies do you know of where the benefit is getting to save an extra +$4,000? To me, this is an incredible incentive to reach that IRS upper limit each and every year.

Bonus tip: Keep in mind that this strategy works per person. If you’re a couple and you both contribute to your own 401(k) plans, you have the opportunity to actually DOUBLE this benefit by saving $4,180 x 2 = $8,360 per year!

Tax-Deferred Growth for Years to Come

If that’s not already awesome enough, now consider this: All that extra savings will now grow and compound each year tax-deferred!

Remember that your 401(k) isn’t just a savings account. It’s an investment account. This means that every dollar extra you contribute has the capacity to grow and multiply for years and years to come.

This additional savings of +$4,000 is no small addition. If we look at just the difference this amount makes by NOT going to taxes, we can calculate that $4,180, over the next 30 years at a rate of 7% annually has the potential to increase to as much as $394,846.

That’s a pretty substantial increase to your nest egg!

Saving More is the Quickest Path to Financial Freedom

I usually recommend maxing out your 401(k) if for no other reason than to simply keep more money for yourself instead of paying it away in taxes.

But there is also another very IMPORANT benefit …

A high level of personal savings is the quickest and surest way to achieve financial freedom!

Believe me. I’ve read hundreds of F.I.R.E (financial independence, retire early) stories. And almost every time, behind each one, you can find that the individual or couple used a high level of savings in order to achieve their goal. In fact, here are six F.I.R.E. stories that you can check out for yourself.

I’m not talking in their 50’s and 60’s. These are people in their 40’s or even 30’s who became so financially stable that they were able to walk away from full-time employment and go do whatever makes them happy.

How is this possible?

It’s due to something I call the double-ended approach to early retirement. By saving more, you essentially teach yourself to live off of less money. This then leads to you needing less money to achieve financial freedom. And thus you reach your goal faster. You can read all about it in this post here.

So now you’ve got two VERY good reasons to strive to max out your 401(k): Keeping more of your tax money for yourself, and reaching financial freedom quicker!

Great! Now How Do I Get My Savings Rate So High?

Being able to contribute all the way up to the IRS 401(k) max is not something that most people will be able to do overnight.

Just like someone on a diet who wants to lose weight, it’s going to take a lot of discipline and will-power to get there. But given time, if you stay consistent, you will reach your goal!

It look us years to get to the point where my wife and I could each hit the IRS max limits. We started off much like everyone else contributing 10% or so to our plans. But little by little, we kept increasing our contributions until we had finally hit the ceiling.

What’s that? It’s a simple little trick where you raise your contribution level every time you get a new raise at work. By doing this, you never end up missing the money because you never know any different from the previous year.

Here’s a more detailed article I wrote about how the 401(k) raise ratchet method works and why it’s so effective. I can definitely vouch for it – it was the strategy I used to slowly bump up our savings rate all the way up to the max!

At a Minimum, Get the Full Employer 401(k) Match

Okay, okay. I perfectly understand that saving all the way up to the 401(k) maximum limit will not fit into everyone’s financial situation.

My goal here was to illustrate just how great this strategy can be if you scaled it for maximum benefit.

At the absolute minimum, there is one threshold you should under no circumstances go below: Contributing as much as needed to get the full 401(k) employer match.

For me, this is the one number that is non-negotiable.

Why? Because anything less than this and you are simply passing up FREE money.

Most U.S. employers will now pay an incentive to their employees in the form of a 401(k) match. Sometimes this might be 50 cents to a dollar. Or sometimes its as much as dollar for dollar. On average, this works out to a match of roughly 2.7% of the employees pay.

Keep in mind that just like your 401(k) contributions, this money is tax-deferred too – meaning you pay no taxes on it right now. PLUS: It grows tax-deferred too!

So if you contribute anything less than this amount to your 401(k), you’re simply leaving money on the table. A LOT of money over time!

Don’t believe me? Just check out how much more that can build up your 401(k) over time at this post here.

To know for sure what this minimum amount should be, go to your 401(k) provider or HR representative and get the details. Every employer’s rules will be different.

What If I Don’t Like My 401(k) Plan or Can’t Contribute to One?

Unfortunately, not all 401(k) plans are the same.

Some offer really good terms while others …. not so much. It all depends on how your employer has setup the plan.

Consider:

Some have lousy or expensive investment options

Some plans charge high administrative fees.

Some don’t allow you to borrow or make it nearly impossible to make a withdrawal, even with a financial hardship.

Some won’t let you file for a 72t or SEPP if you plan to retire early.

If you have encountered these problems or your employer simply doesn’t offer 401(k) plans, relax.

The IRS also gives the option to contribute to a Traditional or Roth IRA. Like a 401(k), these savings plans allow you to make tax-advantaged contributions that can grow and compound your nest egg. But the major difference is that an IRA is under your control; it is completely separate from your employer.

Also, if you’d like more details on how IRA’s differ from 401(k) plans, then please read this post too.

But How Do I Know Exactly How Much I Should Be Saving?

I get it. Maybe you want to save just as much as what you need to successfully retire one day.

But how does someone find out what they number is?

With all the noise that’s out there in financial media, it’s a wonder anyone knows what’s real and what’s just there as link-bait.

I’ve read everything from articles suggesting you save up multi-million dollar nest eggs to moving to third-world countries for retirement. No thanks!

Over time, as I tested my own plans, it became clear to me that a lot of what I was doing could be used by others to help them realize their paths to financial freedom too.

This is what inspired me to write my book “How Much Money Do I Really Need to Retire & Achieve Financial Independence?”.

In it, we take a very straight-forward and practical approach to answering the question: How much do I really need to save? What you’ll discover is that depending on how you want to live in your retirement, you might not need millions of dollars at all. In fact, you might be just as safe and secure with less; not to mention a whole lot happier you were able to stop working much sooner.

]]>http://www.mymoneydesign.com/personal-finance-2/retirement/how-much-should-i-contribute-to-my-401k-plan/feed/26http://www.mymoneydesign.com/personal-finance-2/retirement/how-much-should-i-contribute-to-my-401k-plan/How to Fly to Hawaii On Points – We Saved Over $5,000!http://feedproxy.google.com/~r/MyMoneyDesign/~3/DupHxqS7jLI/
http://www.mymoneydesign.com/personal-finance-2/travel/how-to-fly-to-hawaii-on-points/#commentsMon, 31 Dec 2018 19:45:05 +0000http://www.mymoneydesign.com/?p=10827If you’ve ever wondered how to fly to Hawaii on points, give your family the type of vacation that others only dream about, and save thousands of dollars in the process, then you’re in luck! It’s a goal that is completely possible, and this is our story about how my family and I were able […]

If you’ve ever wondered how to fly to Hawaii on points, give your family the type of vacation that others only dream about, and save thousands of dollars in the process, then you’re in luck! It’s a goal that is completely possible, and this is our story about how my family and I were able to make it happen!

Traveling to Hawaii has been a dream of our’s for quite some time. Ever since I was a small child, I could remember my elderly relatives talking about what incredible memories they had of their vacation in Hawaii. Combine that with that fact that Hawaii serves as the backdrop to dozens of famous movies and iconic moments throughout history, and my curiosity has definitely been peaked!

While there are certainly many other exotic places in the world you could travel to, Hawaii is still a huge must-go-to spot for many travelers. In fact, it still ranks as one of the top destinations to visit within the U.S.

Plus, for U.S. citizens, traveling to Hawaii is less hassle than traveling outside the U.S. Unlike when you travel to the Caribbean or Europe, you can leave your passport at home and only need to take your drivers license with you. For anyone without passports, that saves a family of four over $400 (not to mention the luxury of not having to wait in those incredibly long Customs lines at the airport.)

What’s not to like about flying to Hawaii? Unfortunately the price! When I first started researching flights to Hawaii, I was typically seeing costs on average of $2,000 round-trip per person. $2,000??? For my family of four, that would be a retail cost of $8,000! And we haven’t even talked about also budgeting in the expenses for the hotel, vehicle rental, food, and just plain having fun!

In the beginning, it seemed like this goal was going to be impossible. I could see why so many people shut down when they initially consider vacationing in Hawaii. But then I got into the travel hacking / credit card rewards game and learned that with a little bit of creativity, anything is possible! All over the Internet, I was finding story after story of people who had traveled to wonderful and exotic locations using nothing more than just their credit card rewards points to get there. And Hawaii was certainly no exception!

I thought: Is there a way my family and I could use points to fly to Hawaii? What would be our strategy, and how long would it take to get all of the points we’d need to make this goal possible?

The answer: Absolutely! Now, after having traveled to Maui, Hawaii, I can definitely tell you that getting flights for nearly free is completely possible, and we are living proof! (In fact, please enjoy a few of the photos from our family vacation throughout this post.) With that said, here is our story and how you too can travel to Hawaii on credit card points!

How to Fly to Hawaii on Points – Developing Your Strategy

The incredible Banyan trees of Lahaina, Maui.

Step 1 – Do Your Research!

It’s often been said that nothing in this life is ever truly free. And even when it comes to topics like flying to Hawaii on credit card points, the same is true!

To make this dream a reality, you’re going to have to invest a little bit of time and energy into doing your homework. What do I mean by homework? Mainly this: Identifying which airlines travel to the Hawaiian island of your choice (and on which dates).

This can easily be done by simply going to a free resource like Google Flights or a travel service website of your choice (Expedia, Travelocity, etc.). Do a round-trip, flight-only search and just simply see what the basic options are. For example:

What airlines do you notice? Do some seem to be more frequent than others?

Which dates seem to have the best options?

Are there some airlines that offer more options (free WiFi) or flight duration? For example, a direct flight instead of one with connecting stops or long layovers?

When we started planning our trip to Hawaii, I did a Google Flights search and compared each of the different islands. Right away I noticed that from my home airport of Detroit that almost every flight was through Delta. This was a good fit because we already had a modest amount of miles saved from previous vacations. Therefore, Delta airlines and their SkyMiles frequent flyer program became the focus of my credit card rewards strategy.

Step 2 – Understand the Cost

Another reason its critical to do your research: It’s important for you to understand just how much money the tickets cost normally. This will help you to form a “basis” for later. You’ll easily be able to compare different offers, see which points are providing you the better deal, and this will help you to make informed decisions about which sources to pursue (or if you need to do anything extra such as purchase additional points from the airline directly).

Again, Google Flights or a travel service website of your choice will help to give you a really good idea of the retail price. Personally I like to use Google Flights because it gives you the option to compare flights over several weeks at a time to see which particular dates would be the most optimum; not just for price but also by flight times and other factors of your liking.

In terms of cost, like I mentioned earlier, I was seeing a lot of plane tickets in the neighborhood of $2,000 or more per person. However, through keeping our flight options flexible, I quickly recognized that the island of Oahu (the one with the state capital of Honolulu) had some very affordable dates that were closer to $1,250 per person.

Step 3 – Identify the Right Points System

With a particular airline in my mind and a ballpark idea of the cost, now you can begin to start looking into whether it would be possible or not to use points on that airline.

Going back to my vacation story, when I looked up how many points it would take to go to Oahu, it cost approximately 50,000 to 65,000 depending on which dates we’d pick.

Oahu would be awesome! But honestly, Maui was our #1 choice. So I went back and did some more cost comparisons of Delta SkyMiles to see if I could find anything that would be reasonable. Much to my surprise, I found a few flight options to Maui that were also approximately 65,000 per person. Though 260,000 SkyMiles would be a lot of points to accumulate, it wasn’t a number that would be completely out of reach.

Of course, Delta SkyMiles is just what I preferred to use. You could do this with any airline of your choice: United, American Airlines, Southwest, etc. Again, this is why it’s important to do Step 1 and see exactly which airlines you’ll want to be working towards.

Advanced tip: Keep in mind that many airlines have alliances with one another, and sometimes you might get a better deal by going through one frequent flyer program over another. For example, lots of travel bloggers have often stated luck with using Korean Air to get cheap flights through the Sky Team Partner alliance. Though it requires a bit more research to uncover, it could end up saving you thousands of dollars in the end.

Choppy waters at the Nahiku Viewpoint and Wayside, Maui.

Step 4 – Find the Right Credit Card

Now that you’ve got some idea of how many frequent flyer miles you’ll need, now it’s time to find the right credit card offer for the job!

The best way to do this is to go to any of the top travel websites and look through all of the latest offers for cards that will support your goal. Some of my favorites:

In my case, I needed as many Delta SkyMiles as possible. So I signed up both myself and my wife each for a Gold Delta SkyMiles American Express card with a bonus offer of 60,000 miles apiece and no annual fee for the first year.

Pro Tip: When applying for credit cards, don’t add your spouse to your application. Sign yourself and your spouse up separately for two individual credit cards. That way you’ll each have an opportunity to get the bonus offer and effectively double the number of rewards!

Unfortunately, those two cards weren’t quite enough to give us all the miles that we needed. So I also ended up signing up for the Platinum Delta SkyMiles American Express card that had a bonus offer of 70,000 miles. Though this one had a $195 up-front annual fee, I didn’t mind since it was helping us to save nearly $5,000 on our flights and the card allowed us to check bags for free (this would have cost us almost $200 anyways).

Step 5 – Spend Responsibly!

In almost every case with credit card bonus offers, there is some minimum spending that needs to met. Usually there is also some time period restriction on this spending such as $3,000 within the first 90 days (or something similar).

Be sure to meet this requirement making only purchases that you would normally have made! This aspect is so important that I’ll repeat it again: Only buy the stuff you were going to buy anyways! I really can’t stress this part enough!

Getting a new credit card and making purchases just for the sake of reaching some spending goal is just plain silly. This is not the time to go out of your way to buy a new flat-screen TV or put a down payment on a car (unless you had saved and were planning to make these purchases already). So again, please spend responsibly.

My suggestion would be to make purchases such as:

Gas

Groceries / restaurants

Utilities / cell phone / internet bills

Any other regularly occurring expenses

For example, usually when I get a new credit card where I have to meet a minimum spending requirement, I’ll generally switch over my automatic payments for my electric / gas and cell phone bills. It’s an easy way to cover almost $1,000 of that spending requirement within a short amount of time and with almost no effort!

Step 6 – Claim Your Prize!

So now you’ve meet the minimum spending requirement and been awarded your points. Now what?

It’s time to claim your prize! Go redeem those points for the flights you’ve been planning.

I mention this step because often times some people get caught up in what I like to call “points paralysis” – meaning now that they’ve accumulated such a large balance of points, they are afraid to spend them.

For example, have you ever met anyone who brags to you that they have X-hundred-thousand frequent flyer miles with their favorite airline. To that, I say “Great! So what?” Those points are completely useless unless you plan to spend them on something you and your family will remember. And what’s worse: Those points could even expire if you let them sit for too long. Honestly, there is no reason not to get your full value out of your points and use them for what they are good for: Free travel!

Alternative Strategies for Using Points to Fly to Hawaii

Luckily, my strategy for flying to Hawaii on points was just one example out of many. There are dozens of alternative ways you could use your credit card rewards to get to where you want to go. For example:

Use Airline Arbitrage to Get More for Your Points

The word “arbitrage” is often used in investing to mean making a trade for something at a better price. And airline frequent flyers are no exception!

Earlier in Step 3, I mentioned how Delta is part of a larger Sky Team Alliance. Why is that important? Because lots of bloggers have often said that they were able to book cheaper Delta flights by converting their credit card points to miles through Korean Air first. Here’s a link to an example of how this works. Although I’ve never personally had any luck with it, given that it could end up saving you a few thousand dollars, it’s worth it to look into!

Book Your Travel Directly Through the Credit Card Reward Program

Nearly every major credit card provider with one of these big programs will also offer you the oppertunity to book flights, hotels, etc. directly through their own internal travel portal. And at a discount!

For example, when we were holders of the Chase Sapphire Reserve credit card, each point value was increased to 1.5 if you booked through Chase’s travel portal. Example: 100,000 points ($1,000) was actually worth $1,500 of travel. This is one of the ways we were able to book our all-inclusive trip to Los Cabos Mexico in 2017 for nearly no money out of pocket.

Skip Points and Get Travel Credit

Don’t feel like messing around with points and conversions? You’re not alone! Some credit card companies have already recognized this, and instead make life very simple by offering travel credit instead.

For example, the Capital One Venture card is one that often awards 60,000 points that can be redeemed directly for $600 worth of travel expense. Use this card wisely, and you could easily build up enough rewards to get $1,000 of travel credit.

Don’t Stop At Flights, Get Free Hotels and Vehicle Rentals Too!

Watching the morning sunrise from the balcony of our condo at the Kaanapali Alii, Maui.

Like the idea of flying to Hawaii on points for free?

The good news is that it doesn’t have to stop there! You could really take your vacation budget down to as close to zero as possible. How? By applying the same lessons above from flights to also cover your other big travel expenses such as your hotel and vehicle rental.

Free Hotel Nights

The islands of Hawaii are full of hundreds of hotels – most of which bear popular, big-name brands such as Hyatt, Hilton, Marriott, etc.

Why does that matter? Because just like with the airlines, each of these hotel chains has their own unique point system where you can take advantage. Similar to the savings with flights, it pays to do some research ahead of time to see which hotels cost which amount of points, and then develop your strategy from there.

How can you get started? By far, my favorite free resource is a wonderful site called Award Mapper. Simply type in the location of anywhere in the world you’d like to go, and Award Mapper will show you which hotels chains are available and how many points you’ll need for each night of stay. It’s a HUGE time-saver over going to each hotel chain’s website and researching the point cost yourself.

Before we started looking at Maui for our family trip, using Award Mapper, I noticed there was a Hyatt Place in Waikiki Beach, Oahu that only cost 12,000 points per night. Using a credit card program like Chase Ultimate Rewards where each UR point transfers to Hyatt 1 for 1, this means we could have easily accumulated 60,000 points from opening one card and stayed at this location for 5 nights completely free!

Of course, we didn’t end up staying in Oahu, and I’m not going to lie … hotels in Maui were pretty darn expensive! Like $4,000 or more for the week expensive!!

But it was all good. Thankfully we had budgeted for this and were prepared to pay the cost. And this lead us to two more important things:

Instead of staying in the traditional 400 square foot hotel room, I noticed Maui was full of unused timeshares that you could rent like traditional hotel rooms. So instead we were able to stay at an 1,800 square foot, 2 room condo with full kitchen and living space … for less than what the big-boy hotel chains were charging! Let me tell you … that was REALLY nice! And the best part – no timeshare presentations or any nonsense like that!

Since we knew ahead of time that we were about to drop $4,000 on a single purchase, we thought: Hey, why not get some points for it? We signed up for the Capital One Venture Card because they offer a generous 10x points per dollar spent at Hotels.com. Combine that with the 50,000 introductory point offer, and with ONE purchase we were able to accumulate over 90,000 points on this credit card (+$900 in value).

Pro Tip: If you are planning to make any big purchases in the near future (vacation, home improvement, car down payment), try to find a credit card that will help you turn that purchase into as many points as possible!

Free Vehicle Rentals

If you’re going to stay in Hawaii, you’re going to want to go exploring! And so we knew we were going to need to rent a vehicle for the week.

This is another easy place to spend your points and save between $200 – $500. We ended up finding a pretty good deal on a Jeep and, using our credit card rewards, we ended up saving us approximately $343 more!

Miscellaneous Travel Expenses

Don’t forget that with some of the general purpose travel cards such as Capital One Venture you can use your points to pay for things you wouldn’t normally think about.

For example, we used our Capital One Venture points to pay for the airport parking. This was yet another savings of $113!

Planning to do any sort of activities or excursions? Check the travel portal to see if you can book any of these excursions ahead of time. Or you could always use one of the general purpose travel cards to cover this expense. There are a lot of possibilities!

Disclaimer: I have no affiliation with any of the credit cards or travel sites mentioned within the content of this article. This is simply me sharing the facts of how I was able to achieve this savings with the hope that it will help you to be able to treat your family to the same incredible experience. Good luck!

Readers – What tricks have you found for flying to Hawaii on points? Which credit cards or rewards programs do you prefer to use?